Interest rates of the central banks of the largest world countries are the basis for trading on the Forex market. It is the dynamic changes of this indicator that determine the majority of price fluctuations arising in the course of trading. Interest rates are influenced by both global political and economic factors and domestic events. And each trader should be able to predict market behavior based on changes in interest rates. Of course, if he doesn’t plan to trade at a loss.
Interest rates: basis
The majority of traders, who actively use the information about changes in interest rates in their trading forecasts, choose intraday (short-term) variants of trading. In this case, the profit will be directly related to the growth of the rate of return – the higher it is, the more percent of the profit will be received as a result of investment.
Of course, in addition to changing the rates, there are other factors to consider. For example, exchange rate fluctuations that can completely change the picture of intra-day trading.
Buying currencies with higher interest rates with lower interest rates is an attractive option, sometimes highly profitable, but not a guaranteed return on investment – forecasts based on just one specific indicator are too weak.
The dynamics of changes in interest rates is also effective as an analytical tool for long-term forecasting. However, such auxiliary factors as economic and political news releases should be additionally considered here. But, in general, monitoring of changes in interest rates is a quite effective way of analysis, which allows us to get a fairly objective idea of future changes in the market situation in the short and medium term.
Analysis of interest rate dynamics
The policy of any central bank is to artificially regulate the financial and economic situation in the domestic market. Accordingly, the main focus is on changes in short-term interest rates that determine the terms of interbank lending. An increase in the interest rate is a measure designed to reduce current inflation. The decrease in interest rates leads to an increase in demand for loans and an overall increase in investment in the economy.
Which changes may signal an imminent revision of the rates:
1) increase/decrease in inflation rates in the consumer sector;
2) growth/decrease in the level of expenditures within the consumer market;
3) growth/decrease in the employment rate of the population;
4) dynamic fluctuations of the substandard credit market indicators;
5) changes in price indicators on the real estate market.
Interest Rates: Forecasting
When making forecasts on the dynamics of changes in interest rates, it is important to correlate the obtained analytical data with the forecasts of the Federal Reserve. Otherwise, everything else is quite obvious: as economic indicators grow, interest rates can either stabilize or grow. When the level of economic development decreases, the government usually reduces interest rates, activating the lending market and attracting new clients to it.
In addition, there are two objective factors that could give rise to changes in interest rates:
1) statistical data and forecasts of analytical agencies;
2) statements of officials having a significant status for the economy.
Among the official statements, the speeches of the heads of central banks are of paramount importance in the case of interest rate forecasts. They are able to clarify the general mood of the market and demonstrate the presence of short-term trends in the dynamics of price indicators in the near future.
Don’t underestimate the analysts’ predictions. They are usually the ones who have sufficient knowledge and resources to most objectively assess the future dynamics of interest rates. Of course, you shouldn’t blindly rely on the opinion of a single professional. Use multiple sources to obtain more accurate information and average the data, systematizing it to achieve the desired calculation result.
What interest rates should be taken into account when forecasting?
1) Federal Founds Rate – is relevant for the banks whose activities are regulated by the Federal Reserve System. Valid for the short-term overnight lending market. Interest rate changes in this case are regulated by the U.S. Open Market Committee. Meetings of the Committee are traditionally held 8 times a year. The traditional day of the meeting is Tuesday (the first and the fourth are held in two-day mode, with the decision to change the rates on the second day – Wednesday). The final data on the forthcoming change of interest rates are announced on the day of the meeting – at 18:15 GMT.
2) Refinancing Tender – European refinancing rate set by ECB. Betting changes on such tenders are held every two weeks, on Thursdays. Changes in frequency can only be observed due to the fact that the traditional meeting on public holidays or the summer vacation period for members of the European Central Bank is no longer the case.
3) Bank Rate – the rate of the Bank of England for the lending market under the repo scheme (resale of assets to former owners after the agreed terms). Decisions on changes in interest rates are made on a monthly basis, as part of a meeting of the Financial Policy Committee. Traditionally, a committee meeting is scheduled for the first week of the month (Wednesday/Thursday or Tuesday/Wednesday), and the results are announced on the second day at noon London time.
4) Overnight Rate Target – the rate of the Bank of Canada, which determines the desired level of the short-term depositary market. The decision on changing the rates is made by the Council, which manages the National Bank. The data are made publicly available on the day of the meeting
5) Three-month loans (3 Month Libor), for which the Swiss National Bank sets the betting corridor. The betting can be changed on a daily basis. However, they will all occur within a given range. Changes in the range of rates are made quarterly, traditionally on the third Thursday of March, June, September and December.
6) Official Cash Rate – the main interest rate used by the Reserve Bank of New Zealand. The rate is reviewed 8 times a year, with the results announced on the same day.
7) Repo Rate – the basic interest rate of the National Bank of Sweden (effective within the framework of weekly borrowings), set six times a year at meetings of the Council of the bank.
8) Cash Rate – the base interest rate of the Reserve Bank of Australia. Decisions to change rates are made at monthly (except January) meetings held on the first Tuesday of the month. Data on the decisions made become available on the day of the meeting.
9) Overnight Call Rage Target – the rate on overnight borrowings applied by the National Bank of Japan. Rate changes are set on a monthly basis, as part of traditional meetings.